2023-03-06 03:33:33 ET
Summary
- Benefitting from tax credits in the Inflation Reduction Act. Recharging Stations for EVs provide critical mass to launch into the EV charging station market.
- 22% Global market share in the industrial side of the business. The market for battery cells is growing by 20% per year, reaching at least $360 billion in 2030.
- Price/mix actions start to bear fruit, driving margins higher on non-contract segments by 150bps. Management guiding towards 8% revenue 5-year CAGR.
- Backlog up 2x since pre-COVID, with more orders coming in than orders filled even as supply chain chokepoints alleviate.
Investment Thesis
EnerSys ( ENS ) is an industrial solutions firm focusing heavily on stored energy. ENS has 22% of global stored energy for industrial applications.
While most media coverage on electrification of the economy has focused on consumer EVs, ENS has been powering the industrial transformation and expanding rapidly. Every segment has seen a record backlog ( total backlog $1.3 billion ), with the estimated total addressable market hitting $360 billion in 2030 .
ENS returned $186 million to shareholders through dividends and extensive buybacks in FY22. Though headwinds remain significant in the supply chain, price increases have outpaced input costs for ENS. This has resulted in a 9% increase (record-breaking $920 million) in revenue during 3Q23. We believe that once headwinds subside, ENS will be able to realize sustained revenue increases and increase its share price. Management has guided towards $1.50 EPS for 4Q23.
3Q23 sales were a record, on a quarterly basis, growing 9% year over year. Megatrends continue to move in the direction of sustained demand in the electrification area. We believe that there is still an upside to be realized with ENS, and we think that in the longer term, there could be even more.
Estimated Fair Value
EFV (Estimated Fair Value) = E24 EPS (Earnings Per Share) times PE (Price/EPS)
EFV = E24 EPS X P/E = $6.00 X 20.0 = $120.00
We believe the company’s mid-double-digit EPS growth rate will garner a premium multiple of a PE of 20. We believe that the market is underpricing the expansion in the total addressable market we will see in the second half of the 2020s. We expect EPS to reach $10 per share within 5 years. Additionally, ENS expects revenue growth to accelerate this year to 9%.
Operations
Not much has changed in the operations area since our last article . We will be using ENS’s Adjusted Operating Earnings figures, which are net earnings with amortization, securities fees, and inventory management costs added back in. Growth is solid, and the backlog is up 14%. The backlog coverage ratio averages 1.5x across the company, and book-to-bill remains >1.0x .
Energy systems continue to make up the largest portion of sales, with operating margins expanding by 350bps year over year. Sales are up 12.7%, and adjusted operating earnings are up 169% year over year. A richer sales mix is expected to be realized toward the end of the present 3Q23 quarter. We expect the margin to expand again, though not as wide as 350bps. ENS is currently close to a production-grade fast-charging and storage system. As EVs are more widely adopted, traditional infrastructure like gas stations must be replaced or upgraded to include EV charging. Of consumers surveyed about what is holding them back from buying an EV, 48% indicated that the lack of public charging stations hinders their choice.
Motive power has seen strides in recent years, with ENS focusing primarily on small-vehicle and commercial vehicle batteries. Demand trends and backlogs are strong, just like Energy Systems. ENS is expanding operating earnings margins by 150bps and sales by 6.6%. Demand in electrification and automation is still strong and even stronger in a post-COVID world. ENS will save roughly $28 million in the consolidation of manufacturing operations when the Richmond plant is expanded and smaller satellite plants are closed.
Finally, the Specialty Projects segment is the proprietary solutions for everything from spacecraft to military applications. One of the largest innovations in recent years (and what drove the acquisition of NorthStar in FY19) is the TPPL (Thin Plate Pure Lead) battery. ENS intends to increase capacity for TPPL manufacturing by $1.5 billion by FY24, but this has remained difficult with the heavy backlog weighing down the supply chain. Demand is strong, but sales are only up 4.1% year over year, and margins have contracted. The specialty segment is often dependent on contracts and thus fluctuates quite a bit in margin and sales. Additionally, because most of the work is proprietary or otherwise on a much smaller scale than a full production run, margin expansion will not benefit from scale economics. This division operates more as an R&D center to keep ENS on the cutting edge of technology than a profit-driven business unit.
Strategic Plan
Strategic Presentation, ENS
Capital allocation is moving away from M&A and is going more toward organic expansion. The balance sheet target is a 2-3x debt to EBITDA, and ENS has strong cash flow generation, which will remain as the backlog has regularly outpaced billed amount.
A $185 million repurchase authorization remains. ENS pays a minimal dividend which is only 1% yield at the current price. However, this may improve supply constraints lift, and we expect Free cash to increase.
Inflation Reduction Act
McKinsey estimates that the total addressable market for present battery technology is $85 billion. As ENS expands into different markets, they will leverage the strength and dominant market share in the industrial electrification market to play a key role in the low-carbon future.
Inflation reduction act’s funding allocations and tax credits align with the strategic roadmap of ENS. The direct financial opportunities the inflation reduction act offers are significant manufacturing tax credits for selling battery under section 45. Section 45 provides a tax credit at a baseline of 2.75 cents per kWh produced , and the inflation reduction act expanded these credits to include batteries. The credit is 10% of the cost of the mineral inputs, with an additional credit of up to $35 per kWh of storage. Per law firm Orrick , a 75kWh battery pack utilizing cells would have a $2,625 credit. For reference, a 75kWh battery is one of the most common batteries in usage with EVs . These credits will be realized directly by ENS.
On top of the manufacturing tax credits, there is an incentive tax credit on 30% of the cost of solar + storage for consumers. While ENS does not realize these credits, it will significantly drive the number of people willing to upgrade to solar. Additionally, 30% of the cost of commercial EVs will be covered by tax credits. This will increase demand in the B2B area, where ENS thrives.
Risk
The risks from our previous article have not changed in the area of procurement. Rare-earth metals will continue to be expensive and hard to acquire. Last time we also discussed how ENS continues to raise prices and adjust mix as input costs fluctuate. While this is still the case, the Inflation Reduction Act has assisted in keeping the costs of electrification down.
The electrification space is hot, with lots of well-funded new firms backed by venture capital and SPAC money. As companies compete, there could be an erosion in pricing, especially if demand is disappointing or delayed.
Conclusion
ENS is an unknown leader in industrial electrification. Hundreds of billions of dollars in industrial electrification need to occur by 2030. ENS is in a position to get a significant share. ENS has consistently had a price/mix adjustment that has outpaced cost increases. EPS is expected to surge in 4Q23 as even more bottlenecks dissipate. Seeking Alpha projects a 14.7% increase year over year. If they are successful in the consumer recharging business, growth could go exponential. We have confidence in ENS for the long term and believe it is still a buy. ENS presents an opportunity to get into a little-known growth company before Wall Street catches on.
For further details see:
EnerSys Growth Is Electrified By IRA